Thursday, January 28, 2010

Prof. Meltzer demeans himself by even addressing the Fed’s ridiculous proposition that by paying interest on reserves the Fed can control excess reserves. Where is the reserves interest going to come from? This is just another underhanded way to try to recapitalize the bad banks (not all banks are insolvent).

Meltzer instead suggests the Fed use the traditional method of selling securities to suck in high-powered money. But what are they going to sell, and to whom (the “Wall Street question”)? The Fed has taken in untold and literally unknown amounts of garbage as if it were worth being reserves—they won’t even tell us what it is or how much of it has already charged off!

If and when inflation becomes a problem (when the next Big War gets going) the Fed won’t have the balls to reign in anything, would be my guess. And we know the Whole Sick Crew of neoclassical economic advisors to the President are on record as welcoming an inflation to “lower the debt load.”

In the meantime the only thing that will restore a healthy middle class to America is an explicitly redistributionist rebalancing of aggregate demand. Let the ruling class that has engineered the economy and the tax system to its own benefit for the past generation start to pay its own bills—especially the gigantic Wall Street bailouts, the largest transfer of wealth from ordinary Americans to the wealthy in history.

[I hate to admit it, but a rebalancing of aggregate demand that put more money in the hands of the middle class would also increase the odds of a “benign” mild wage-price inflation getting going. Combine this with a concerted effort to get big American corporations to knock their preening executives off their pedestals—who strut through the halls wearing expressions that say, “We are gods, oh ye puny cube-dwellers! Do not think that you are even the same species as we! You will never join our club!”—and get pay ratios in America back toward something that doesn’t cause gagging, and the economy might just pick up steam….]

Raise marginal tax rates on the super-rich to where they were in the 1950s (see this), the last time the federal debt load was this high.

I called my Senators today and told them to dump Bernanke.

P.S. The Fed always has reserve requirements to reign in excess reserves.

P.P.S. If the Fed had not bailed out the banks, and instead had provided unlimited deposit protection, what would have happened? There would be a large amount of high-powered money in the hands of the public rather than in the banks. The public could have made runs on as many banks as they liked, and the banks that lost their deposit base failed, and there would have been no massive wealth transfer to the investors in the failed banks—but the executives of the banks that levered up irresponsibly would be out of work, instead of cracking jokes to Congress about financial crises being something that come around every seven years, and paying themselves record bonuses. Would this have been inflationary? No. People are reducing their marginal propensity to consumer, and increasing precautionary demand for money. When things calmed down, they just would have put the money back in a bank.

Tuesday, January 26, 2010

Comstock has published Ned Davis’s charts on total debt/GDP for years. They wonder why no one among the financial pundit (i.e., dunce) class can see the elephant in the room.

Barron's magazine printed the first part of its annual Roundtable discussion of 2010 this past week. We noticed that many of the participants were very concerned about the debt (mostly government debt while we think total debt is a much more useful metric). Marc Faber, in fact, talked about a 7,000 word New York Times article by Professor Paul Krugman. He stated that the article "How Did Economists Get It So Wrong?" never mentioned that excessive credit growth or leverage was the cause of monetary instability and brought about the financial crisis. Bill Gross stated that by lowering interest rates we promote consumption instead of manufacturing. Central bankers were forced to respond with liquidity to a problem that developed over the past 25 years. There was more discussion of credit growth (another way to say debt growth) in the macro analysis that is always presented in the first part of the three Barron's articles of the Roundtable. The amazing thing to us is that most of the roundtable participants understand the same problems we talk about almost every single week, yet are mostly very positive on the market for 2010.

It seems that most of the roundtable participants understand the debt problem we have been talking about for the past 14 years. The worst period of the debt explosion started with the outrageous internet bubble in the late 1990s, continuing through the correction in the internet bubble, then the housing bubble which should have been obvious to everyone (even the Fed) and then the financial crisis of 2008. We are astounded that we have the potential for another bubble in the stock market now. We expected the rebound from a much oversold market in March of 2009, but not a 70% rebound from the lows. We don't believe it is possible to fool the investors in the US stock market one more time. Especially this close to the 2003-2007 and 1996-2000 bubbles.

They expect competitive devaluation as I do in what I call the “supernova of Bretton Woods.” See the pdf on “The Cycle of Deflation.” However, I am more concerned that desperate governments will resort to war, a tried and true inflation-starter, to counter currency appreciation due to deflation. You’ve got to have inflation to devalue your currency under floating rates.

Anyway, their bearish view of the US stock market matches mine, and raises the question: What will Ben’s (or whoever’s) next [asset] bubble be, the chances for wage-price spiral being about nil as the jackboot comes down on the labor market Big Time?

I am going to guess it’s Oil. Goes hand-in-hand with geopolitical instability. But as I wrote in the last “animal spirits” update, we’re likely to experience a period of eerie calm (and further deflationary real estate wreckage as the next wave of resets hits) before any wage-price inflation happens.

This is not to say that there is no inflation. Anyone who buys gas or goes to a grocery store can see it in their monthly budget.

Monday, January 25, 2010

So long as we practice triage along the way, radical change is okay. Actually, radical change is upon us whether we practice triage or not. The mystery to me is how we can get representatives in Congress who aren’t merely pimps for the moneyed interests that got them in. At a time when the federal budget is hemorrhaging, income (and wealth) inequality is at century-level highs, and marginal income tax rates on super-high incomes are at multi-generational lows, why isn’t the government asking those who can afford it to do a little more? The share of income going to the top 10 percent is 50 percent! The share going to the top 1 percent is more than a fifth! The share going to the top 0.01 percent is 6 percent! Why can’t these people pull their oar? (See this paper by Emmanual Saez.)

Shouldn’t this be a no-brainer? And we don’t even hear it being discussed. Disgusting.

I will just note in passing that I don’t believe these people have done anything fundamentally to deserve these incomes. The heads of major corporations thirty years or forty ago, when America was growing far faster than it is now, were content with much smaller multiples of average incomes—as are heads of corporations in other developed nations. Almost as if they recognized that they alone were not responsible for the company’s creation of jobs and wealth! Our ruling class has done this because we let them do it. They have manipulated incomes before tax to their advantage, and then gutted the progressivity of the federal income tax to ensure maximum possible personal benefit. And the charming Pied Piper who sold this bill of goods to the American people was Ronald Reagan.

Friday, January 22, 2010

Economic historian Peter Bernholz has identified that inflation starts to take on hyperinflationary characteristics some time after the deficits of a country as a share of government expenditure rise above a third and stay there for several years.

According to Bernholz, the great hyperinflations of France, Germany, Poland, Brazil, and Bolivia all occurred after deficits reached that magic percentage or higher (In Bolivia, it reached 91%). The United States crossed over the Bernholz line last year.

The time lags for onset of the disease vary following the indication.

A word about the definition of inflation: Monetarists and Keynesians alike (neoclassical economists) generally follow Friedman in saying “inflation is always and everywhere a monetary phenomenon.” Some Austrians say inflation is money supply growing faster than real product.

For practical purposes, let’s define inflation as a general and sustained rise in prices, all prices, including consumer and producer prices. This is very different from a localized asset inflation such as America has recently experienced in stocks and real estate and commodities. Let’s call these “asset inflations.” Asset inflations are not so good at reducing real debt loads, as most people’s incomes (and wealth) don’t follow asset price bubbles upward—and they are definitely left behind when the bubble bursts.

For a general inflation to get going there must be a “wage-price spiral,” so that incomes rise to meet or at least follow the general rise in price level. Hence, I define a general price inflation as “a labor market phenomenon accommodated by monetary policy.” The money supply does indeed grow faster than real product in such a case.

I go through all this merely to point out the unlikelihood of a general inflation in the current environment, in which labor unions are nearly extinct, employment-at-will is the law of the land, fascistic Storm Troopers routinely terrorize citizens for trivial infractions, basic Constitutional rights to due process have been destroyed (the Government can “disappear” you legally if they designate you a “terrorist”—hold you forever without any due process, torture you, do whatever they like with you), and for the most part citizens respond by cowering in their homes, afraid they will be next to run afoul of the dystopian corporate police state, to drop into poverty and a life of internal exile or worse.

Now, the monetary authorities, in their wisdom, would actually like to see a general inflation, as this is their deus ex machina for dealing with excessive federal debt loads (debts of all varieties, really). Hence, I expect the national governments, goaded by their monetary wizards, to try to “enfranchise” the working populations of the world somehow, in a desperate last stand of Bretton Woods (II). If successful, they will accomplish nothing less than the the supernova of Bretton Woods II, a global hyperinflation.

And hyperinflations generally end up permitting those with money and access to leverage, the Big Money, to expropriate the working folks of whatever they had left, and if historical precedent applies, to set the stage for full-bodied Fascism to arise.

The solution: raise taxes on the rich in America who have twisted the income distribution so much in their favor, and provide workfare and health benefits to the people. There is enough to go around. We don’t need to run huge deficits, we don’t need to cut taxes on the rich, we don’t need more war.

Shame upon the ruling class of America! You sit and watch as this happens without the slightest pangs of conscience? As if you don’t know what is happening? Shame upon you!

Wednesday, January 20, 2010

Scott Brown’s victory in Massachusetts was a cruel irony from the point of view of anyone wishing that barbaric America might actually provide its citizens with universal health care. The irony is that Massachusetts already did it, and didn’t want a Washington plan that would have cost them more money. Ted Kennedy must be rolling over in his grave.

That, and according to Democratic pollsters, a pervading dissatisfaction with the President’s lack of backbone in standing up to the oligarchs of Wall Street. The memory of Franklin Delano Roosevelt may run strong in Massachusetts. The health insurance stocks rallied. Given the fiscal woes of the states now it is unlikely that any will be in a position to emulate Massachusetts’ plan.

Dysfunction at a national government level is just what the top 1 percent of the income and wealth distribution want. They’d be happy to see an independent candidate run for president in 2012. The more the merrier! Nothing will get done! Marginal tax rates on super-high incomes will remain at multi-generational lows! The rich can continue to hollow out America, to create serfs where there once was a middle class.

Wednesday, January 13, 2010

Steve Waldman on interfluidity.com, linked to at nakedcapitalism.com, has referenced some of my reference rants on inequality in a nice list of references on inequality. Before starting The Animal Spirits Page I contributed frequently to interfluidity.com. Today I was happy to thank Steve.

This paper examines performance in a tournament setting with different levels of inequality in rewards and different provision of information about individual's skill at the task prior to the tournament. We find that that total tournament output depends on inequality according to an inverse U shaped function: We reward subjects based on the number of mazes they can solve, and the number of solved mazes is lowest when payments are independent of the participants' performance; rises to a maximum at a medium level of inequality; then falls at the highest level of inequality. These results are strongest when participants know the number of mazes they solved relative to others in a pre-tournament round and thus can judge their likely success in the tournament. Finally, we find that cheating/fudging on the experiment responds to the level of inequality and information about relative positions. Our results support a model of optimal allocation of prizes in tournaments that postulate convex cost of effort functions.

This seems plausible to me. The question for Americans going forward is whether we descend into neo-feudalism–which implies long-term economic decline if the above is true–or whether our income and wealth distributions can be returned to something that most Americans find to be fair. Simon Johnson is correct in saying that the country is currently being run like a banana republic ("with nukes"). But the inequality has been long in the making and extends across virtually all occupations.

Most Americans today believe in some way or another that the social contract is broken. The most compelling historical theory of this that I've found is Strauss and Howe's The Fourth Turning, which suggests that we're heading into a crisis over the next decade or more that will require a rewrite of the American social contract. It's going to be interesting.

Tuesday, January 12, 2010

Keep these idiots in the ivory tower. Here is an entertaining and damning video featuring Bernanke and Krugman trumpeting their total ignorance of the real world in the mid 2000’s. And the Fed is going to be our “systemic risk regulator”? It’s our systemic risk creator! h/t patrick.net

In a new paper presented Monday at the annual meeting of the American Economic Association, Carmen Reinhart of the University of Maryland and Kenneth RogoffofHarvard study the link between different levels of debt and countries’ economic growth over the last two centuries. One finding: Countries with a gross public debt exceeding about 90% of annual economic output tended to grow a lot more slowly. For advanced countries above the 90% threshold, average annual growth was about two percentage points lower than for countries with public debt of less than 30% of GDP.

The results are particularly relevant at a time when debt levels in the U.S. and other countries at the center of the financial crisis are rapidly approaching the 90% threshold. Gross government debt in the U.S., for example, stood at 85% of GDP in 2009 and will reach 108% of GDP by 2014, according to IMF projections. The U.K.’s gross government debt stood at 69% of GDP in 2009 and is expected to reach 98% of GDP by 2013.

“If history is any guide,” the rising government debt “is very troubling for the U.S. and other advanced economies,” says Ms. Reinhart.

As I showed in a recent post not only is the income distribution at record levels of inequality, but the rich aren’t pulling their oar the way they used to in the gung-ho, we’re-all-in-this-together postwar era that began during World War II. It is that social contract that is broken.

It is well-known that the bulk of tax revenues come from upper income earners, and that approximately the bottom 40 percent of the income distribution pay no explicit federal income tax (but we do apply the highly regressive “payroll tax” for Social Security to them).

So when I read stuff like the quote below from John Mauldin (or Mish Shedlock, or Peter Schiffer or any number of other pseudo-libertarians shills who advocate tax cuts for the rich to stimulate the economy)—well, insert your own synonym for “gag me”:

The Great Experiment

So this is the backdrop as we look into the future. Unemployment is rising and is likely to remain stubbornly high (over 10%) for some time, except for the few months this coming summer when the Labor Department will hire hundreds of thousands of temporary census workers. The savings rate is rising, and consumer spending is at the very least challenged. The stimulus starts to drop sharply in the latter half of the year. States, counties, and cities are short about $260 billion and will either have to cut services (and thus jobs) or increase taxes. Housing is likely to get weaker, as there are large numbers of defaults coming because of mortgage-rate resets this year and next (more on that in a few weeks). Valuations on stocks are in the high range, and do not portend well for long-term returns.

Further - and this is the most important item to me - Congress is likely to allow the Bush tax cuts to expire and to add insult to injury with some form of large tax increase for heath care. Between the local, state, and federal tax increases, we could see a massive increase in taxes of perhaps $500 billion in a $13-trillion economy, or about 4% of GDP.

Think about that for a moment. It is likely we will begin 2011 with close to 10% unemployment, if not higher. Christina Romer's work shows that tax cuts have a three-times benefit to GDP. Tax increases presumably have a similar negative effect. (Ms. Romer, by the way, is President Obama's Chairwoman of the Council of Economic Advisors. This is not a partisan idea.)

This is the great experiment to which we are going to be subjected. There are those who agree with Art Laffer and company that tax cuts are a positive for the economy (that would include your humble analyst). And there are those who contend that the economy did just fine in the Clinton years before the Bush tax cuts and that we will do just as well if we take them away. And further, taxing the rich a little more is not really going to change their behavior.

My contention is that if such a tax increase is enacted all at once, the economy will at a minimum dip back into a nasty recession. If I am wrong, then I will have to abandon one of my long-cherished beliefs. I will have to stop arguing that tax cuts are as important as I think. Right now, when I read the data and studies, they confirm my tax-cutting bias. But I have to be willing to change my mind if The Great Experiment proves me wrong.

But if you think unemployment is high now, you will really not like what happens if we dip back into recession. It could go a lot higher. They are truly risking a great deal if they decide to pursue this experiment.

When the problem is the distribution, not the level, focusing on aggregates (like the economy is probably “out of recession” now according to GDP and Industrial Production, dude) is wrong. We need to rebalance aggregate demand, not stimulate it with tax cuts for the people who already have all the money.

It is important to remember that in this analyst’s opinion one of the “authorities” cited in the article, Arthur Laffer, is one of the great intellectual frauds of the past couple of generations in America, providing, as the story goes, the intellectual justification for Ronald Reagan’s tax cuts for the rich on the back of a cocktail napkin (there is poetic truth in the urban legend).

We know that supply side economics failed miserably. The tax cuts were not “self-financing,” and the federal government led the country down the primrose path of living on plastic. From this point of view Bill Clinton and his foes in the Republican Congress were the best thing to happen to American fiscal policy in the past fifty years. Reagan inflamed the brass-ring dreams of Americans cut taxes for his “base.”

At the same time, in virtually every line of work in America, those at the top decided that they deserved a bigger share and went ahead and took it, because they could (as Ronnie had sufficiently bamboozled everyone else with his gub’ment-and-taxes-are-evil, you-too-can-be-rich Irish charm). Until we can get income multiples from CEO to average worker back into a range that most people consider fair (possibly through some sort of incomes policy), it is fair to say the top 1 percent will not be significantly damaged if their taxes went up to levels that have been acceptable to the American people for most of the last two generations.

It is the greedy manipulation of the American economy and government by the rich that is different today. Their tax burden is in fact a lot less than historical averages.

Tax cuts in the current environment will accelerate the transformation of America into a neo-feudal state. We need to raise marginal tax rates on the top 1 percent, in part to dispel the notion that they are “sovereign individuals.” As John Dunne put it, no man is an island. Or to quote another source (which I have recently been enjoying in an illustrated version by R. Crumb), the answer to the question, “Am I my brother’s keeper?” is, “Yes.”

From an economic point of view, the American productivity miracle of the postwar period was based on more than technology, but on a spirit of teamwork that may very quickly be lost if American turns into a society of moneyed gentry and neo-serfs.

I forgot in the update yesterday to include the updated “recession probability” chart. No NBER-type recession in sight.

But American society and its economy continue to be very sick. At at time when the have-nots most need work it appears to harder to get than any time in the past thirty years.

It’s my view that there are innate standards of fairness in the human breast that must be satisfied if pathologies are not to become severe. Whether the corporate state can ever overcome its bias toward greed is unclear. But I will speculate, optimistically, that corporations with flatter corporate income distributions will at some point gain a productivity advantage, that may lead to social change. “Pension fund socialism,” as Peter Drucker called it, has failed—even if American workers technically own American companies through their pension funds and 401(k)’s the money managers have insulated company managements from any meaningful shareholder action by voting the “Wall Street rule” (for management) routinely.

Let’s see the leaders of American corporations take the lead in reestablishing a sense of fairness by taking less out of their companies for themselves. Economists can quibble endlessly about whether inequality has in fact increased or whether it has any effect on productivity (see a realclearmarkets.com summary of a recent study by Robert J. Gordon indicating that it’s all an illusion…) but the perception of gross unfairness is out there.

Social change is coming, but not from Barack Obama. It my fellow (exceedingly hard working) blogger George Washington is fond of saying, change springs up from the grass roots.

Friday, January 8, 2010

To begin with I’d like to cite some excellent digging that zerohedge.com has done with published Treasury data that indicate an awareness on the part of the administration that the income distribution is indeed hosed and the best way, ceteris paribus, to cure what ails us is to channel more money to those without:

My preference would be for a livable dole for the unemployed based on workfare but getting that through the obstructionists (Republicans, in this term) in Congress is apparently not possible. The administration doesn’t know how to attack the root causes of our problems, or doesn’t feel strong enough to do it, but they know how to print money and throw it at problems (kind of like chimps throwing something else at attackers…).

Unemployment in December remained constant at 10.0 percent on a fall in the labor force that pushed the participation rate to it lowest level in five years. The U-6 unemployment of all unemployed and involutarily employed part-time and discouraged workers rose to 17.3 percent.

So what will happen to “animal spirits”? They will continue to rise as forecast, sluggishly, as Americans adapt to the current situation, to peak about late 2012, to be followed by another deflationary collapse as all the bad debt the government refuses to deal with implodes on the economy, and we crash from the ultimate debt-financed binge at the end of the age, so to speak.

Here is the big picture on “animal spirits”:

And for good measure, a close-up:

I have assumed the the track of unemployment, after a little more on the upside, will track the slope of previous recent declines in the business cycle “expansion” (I put expansion in quotes because only the top few percentiles of the income distribution have participated in the past several expansions).

The increase in “animal spirits” or general confidence levels is mirrored in a decline in other financial market based measures of risk aversion, namely the Baa-Aaa spread that shows the degree of risk aversion in the corporate bond market. We made a great call on the topping of this spread early in the year that has some ways to run:

From a social psychology point of view the problem is that we’re entering another false dawn, kind of like “morning in America,” where the federal debt binge really got started, by the way, and since, as mentioned, our leaders are doing nothing to right the fundamental wrongs, we’re headed for another collapse similar to the last one. The politicians can be counted on to do absolutely nothing unless hit over the head by economic conditions, and disenchantment with the current administration may lead to a gridlocked Congress.

America will enter an eerie calm over the next couple of years. The rich will pretend that everything is all right and go with their lives as usual. The middle class will lay in their beds at night wondering if they will be next, as they watch friends and neighbors grind into destitution and depression with long-term job loss, loss of house, loss of any shred of middle class socioeconomic status. It will be an America profoundly divided beneath the surface, not by political lines, but by what are effectively entitlements bestowed upon the “haves” by a system that (except for some hidden indications, like the anomalous Treasury spending noted above, and perhaps by the tax increase on the rich that is allegedly part of the health insurance expansion bill) increasingly turns a blind eye to the those at the bottom of the socioeconomic heap.

America is not becoming a banana republic, a hollowed-out state. It is one. The ruling junta is the Greed Party, also known as the the Money Party. The postwar American social contract based on shared sacrifice and working together is broken, and must be restored.

Tuesday, January 5, 2010

Krugman Sees 30-40% Chance of U.S. Recession in 2010 – Proving once again that he knows nothing about business conditions or how the real economy actually operates, Paul Krugman is forecasting a significant chance of “recession” in 2010. Now, the definition of “recession” is political, made by the National Bureau for Economic Research, usually well after the event; and Krugman is an Establishment insider, so he may know something I don’t, namely that the NBER is planning on changing their “definition,” which usually tracks the slope of Industrial Production and a few other primary economic series pretty well. My recession forecasting model, which forecast the 2001 and 2007-? recessions from a year or more in advance, says “no recession in sight” (in the traditional NBER sense), but rather, a basically L-shaped chugging ahead at some finite positive slope. Here’s the chart from the last update:

Sometimes I just want to grab Krugman by the neck and yell, “The economy doesn’t go into recession with the yield curve as steeply sloped as it is now, Paul!”

My best-guess is still that we’ll limp along for a couple of years, weathering the next waves of rate-reset defaults on exotic mortgages, until the next debt-deflationary collapse around 2013. That is when the fiat money hits the fan.

The best way to get an inflation (or hyperinflation) going, historically, has been to be at war. It is my working hypothesis that all the idiotic fiat monetary authorities of the world are conspiring to inflate their way out of their unmanageable debt loads, so we should see all the monetary Wizards gathering with all the Daddy Warbucks by mid-decade to expand our endless wars.

That is, unless a new government is put in place.

Timothy Geithner Meets Vladimir Lenin - John Hussman on the Fed and Treasury’s overstepping their legal authorities and the likely consequences for taxes paid by the American people. Must reading. Remember, Tim Geithner “forgot” to pay $35,000 in federal taxes. Raise marginal rates on incomes over $1 million to 90 percent! Bring the ruling class back down to earth! Let them know that they are not gods!